Remittance, Institutions and Investment Volatility Interactions: An Intercontinental Analysis

• Author: Ibrahim D. Raheem,Kazeem B. Ajide,Oluwatosin Adeniyi
• Published date: 01 December 2017
• DOI: http://doi.org/10.1111/saje.12162
• Date: 01 December 2017

REMITTANCE, INSTITUTIONS AND INVESTMENT

VOLATILITY INTERACTIONS: AN INTERCONTINENTAL

ANALYSIS

KAZEEM B.AJIDE

†

,OLUWATOSIN ADENIYI

‡

AND IBRAHIM D.RAHEEM*

Abstract

Generating massive investment for growth and development has been one of the main policy

goals of most economies around the globe. Countries, most especially developing ones, are highly

susceptible to investment volatility owing largely to the fragile nature of their economies as well

as weaknesses in terms of dysfunctional institutions. Therefore, sound economic management

suggests the need to better understand possible sources for mitigating the adverse effects of invest-

ment volatility. Remittances have been identified as important capital flows which do a good job

of dousing macroeconomic volatilities. It is on this basis that the study sought to uncover the

causal relationship between remittances and investment volatility via the intermediating role of

institutions. Using a panel of 70 countries and the system Generalized Method of Moments

(GMM) estimator, three insightful outcomes come to the fore. First, remittances played counter-

cyclical roles across the estimated regressions. Second, institutional quality had no significant role

in mitigating investment volatility and lastly, the interactive terms of both remittances and insti-

tutions significantly mitigated the negative impacts of investment volatility with the exception of

the political component of the institutional architecture. Policy suggestions are drawn based on

our results.

JEL Classification: E2, F2, F21, F4

Keywords: Remittance, institutions, investment volatility, Generalized Method of Moments

1. INTRODUCTION

Of all foreign capital flows, remittances continue to receive a special attention owing

to its beneficial impacts particularly in developing economies. In principle, these

benefits are usually traced to migration motives chief among which are the notions

of altruism and co-insurance. On the empirical front also, several studies have estab-

lished that remittances help in smoothing consumption in the face of economic

downturns

1

; act as shock absorbers in times of socio-economic crises as well as pro-

vide an insurance cover against diverse forms of uncertainties and risks

2

. In addition,

* Corresponding author: PhD Candidate, School of Econom ics, University of Kent,

Canterbury, UK. E-mail: idr6@kent.ac.uk

†

Department of Economics, University of Lagos, Lagos, Nigeria

‡

Department of Economics, University of Ibadan, Ibadan, Nigeria

1

See, for example, Chami et al. (2005), WorldBank (2006), IMF (2005), among others.

2

Financial transfers from migrant workers are a form of insurance for developing countries

against exogenous shocks (Lucas and Stark, 1985; Kapur, 2004; Lopez-Cordova and Olmedo,

2005; Rapoport and Docquier, 2005; Yangand Choi, 2007).

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C2017 Economic Society of South Africa. doi: 10.1111/saje.12162

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South African Journal of Economics Vol. 85:4 December 2017

South African Journal

of Economics

remittances

3

have not only been widely acknowledged as the second largest source of

external financing after foreign direct investment, but also the most favoured in

respect of resiliency to business cycles and other socio-economic shocks (See Ratha

2003; Ratha and Mohapatra, 2007; Chami et al., 2009; Bugamelli and Paterno,

2011; Raheem, 2015; for more details).

Notwithstanding, there are also dark sides to the foregoing positive narrative on the

development effects of remittances. These include, but are not limited to, causing inflation-

ary pressures

4

, lowering labour force participation rate and engendering real exchange rate

appreciation

5

. In this study, one key interest is examining the connection between remit-

tances and investment volatility as hypothesised by Backus et al. (1992), Razin and Rose

(1994) and Hirata et al. (2004). These authors predicted that increased cross-border capital

flows enhance substitution possibilities between domestic and foreign investments, and

hence, increase investment volatility. They also argued that when restrictions on cross-

border capital flows are reduced, the possibilities of substituting foreign for domestic

investments increase, which in turn amounts to an increase in investment volatility. There

is yet another question of concern beyond the remittances-investment volatility relation-

ship. This is related to empirically investigating the hypothesis that the nature of the core

relationship between remittances and investment volatility is contingent on the institu-

tional framework in place. For instance, sound institutions are important in providing the

enabling environment for potential investors and entrepreneurs. Several studies have pro-

vided evidence in support of the desirable macroeconomic impacts of good institutions in

ensuring development outcomes. For instance, Rodrik (2004) notes that institutional qual-

ity holds the key to prevailing patterns of prosperity across countries. He also argues that

wealthier countries attract investors because of the presence of effective property rights and

the rule of law, as well as the existence of monetary and fiscal policies that are grounded in

solid macroeconomic institutions. The converse, in his view, holds in poorer countries

where these arrangements are tenuous. In essence, in Rodrik’s view, “institutions rule.”

Another study by De Soto (2000) also submits that the institutional framework is vital in

guaranteeing the interests of third parties, thereby ensuring that investors’ funds are not

expropriated. Without the enabling environment and the security of third party interests,

the incentives to invest are stymied (Brafu-Insaidoo and Biekpe, 2011). Furthermore, Roe

and Siegel (2011) also argue that institutions that do not rein in corruption, secure prop-

erty rights, stream-line government interventions and legal procedures work to stifle invest-

ment. Similar conclusion can be further drawn from several other studies that submit that

countries characterised by poor institutions tend to be stagnated (See Acemoglu et al.,

2005 for a more detailed narrative).

3

Since 1998, remittances – at least through official channels – have been second only to FDI flows,

but several times larger than other private capital inflows and official aid (IMF, 2005; World Bank,

2006; Chami et al., 2008).

4

Some authors have argued that remittances hinders economic growth by simultaneously increas-

ing the price of domestic goods and reducing the competitiveness of exports – a phenomenon

known as the Dutch disease – (Bourdet and Falck 2006; Acosta et al., 2009).

5

Remittances may equally be harmful to the long-run growth of recipient economies through an

appreciation of the real exchange rate, which tends to be detrimental to the traditional tradable sec-

tor which is purported to lose competitiveness via a combination of spending and resource move-

ment effects (Amuedo-Dorantes and Pozo, 2006; Acosta et al., 2009).

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